Wells, B of A: A Tale of Two Capital Ratios

If the financial industry were made up of nursery rhymes, Wells Fargo & Co. would be Little Jack Horner and Bank of America Corp. would be regarded as Pinocchio.

As evidenced by the reaction to the two banks' second-quarter results on Tuesday, Bank of America is plagued by a lack of credibility among analysts and investors. That's a problem Wells Fargo, which continues to pull out plum earnings, has been able to avoid.

The divergence in the two banks' bottom line results was stark. Wells Fargo had record earnings, while Bank of America reported a big net loss. Both banks continued to feel the brunt of the sluggish economic rebound, reporting anemic revenue.

The primary concern for analysts and investors, though, seemed to revolve around capital levels, a subject of ongoing consternation and confusion. Though banks have until 2019 to meet Basel III requirements, there is still some uncertainty over how the requirements will be phased in for each bank, and the effect of future economic setbacks on those capital levels. Here is where the differences between B of A and Wells might be most profound.

"There is a massive amount of confusion out there over when you have to be at these capital levels," said Paul Miller, an analyst at FBR Capital Markets. "I think because the JPMorgans, the Wells are already there puts extra pressure on somebody like a Bank of America. What we don't know … is are they legitimately going to have a capital hole they have to fill? The capital numbers are all over the place. Nobody can figure out what the risk-weighted asset numbers are."

Bank of America adamantly stated on Tuesday that it does not need to raise additional capital, but during a conference call with analysts, there were several questions seeking more details on how it had come to that conclusion.

"The sheer amount of capital we have, if you just step back and think about it compared to where we were 12 months ago or 24 months ago, is quite high, including both on a ratio side and [in] raw dollars," Chief Executive Brian Moynihan said. "So we continue to make improvements that makes us feel comfortable, and we got to continue to show you that bridge each quarter as we execute."

The bank expects to have a tier 1 common ratio between 6.75% and 7% by January 2013, well above Basel III capital requirements of 3.5% for that time.

Wells, on the other hand, now estimates that its tier 1 capital under Basel III rules stands at 7.4%, growing quarter over quarter despite a return to paying out dividends and buying back shares.

The discrepancy in capital isn't just a matter of the companies' current ratios. Also aiding Wells is the expectation that the bank's business focus will result in lower capital requirements than Bank of America and its largest peers. Given Wells' comparatively small, though growing, capital markets business, it may sidestep some of the benchmarks for systemic importance.

But Wells Fargo's ability to avoid capital concerns has as much to do with investor perceptions and recent history as it does with the company's relatively strong current levels and probable ability to avoid maximum Basel surcharges for "too big to fail" banks.

When Wells Fargo said that its $125 million mortgage-backed securities settlement "should resolve pending securities law claims for most purchasers of our private label securities," it did so without provoking guffaws from analysts. Bank of America, meanwhile, hasn't been able to avoid skepticism that its legal troubles are under control.

"I don't see their credibility," said Miller of Bank of America. "A lot of the comments they made over the years have come back to bite them."

For one, projections of a dividend raise in the second half of this year were shattered when the bank's initial proposal was denied by the Federal Reserve. The bank also said at one point it would fight putbacks from private mortgage-backed securities investors loan by loan, only to turn around and enter into the $8.5 billion settlement.

"There're a lot of things they made comments on that they had to backtrack on," Miller said.

Nancy Bush, founder of NAB Research LLC, said she thinks B of A will be able to meet the Basel III requirements but "whether the market trusts them is another issue."

Outside of the market's distrust of management, there are concerns over the general economic outlook.

"People, I think, are assuming the worst," said Erik Oja, a banking analyst at Standard & Poor's Equity Research.

For now, Moynihan remains steadfast in his outlook on the bank's capital.

"We factor it all in in terms of our expectations of when litigation costs will come or when asset sales … will take place, if any, and how they will affect it," he said. "So it's in our estimate and … we will give you a quarterly report of how we are improving them and the progress we are making."

Jerry Dubrowski, a spokesman for the bank, tried to clarify.

"We were able in the second quarter to withstand a $20 billion charge to our mortgage business, all in," he said. "And we saw our tier 1 capital ratios drop but still be above year-ago levels, and I think that's an important element of how strong the company is from a capital perspective. … Then the question becomes over time can you rebuild the capital that you lost, and our feeling is that we can. Not only are we talking about rebuilding the capital but we're talking about entering 2013 being twice what the regulatory capital minimums would be under Basel III."

Subscribe Now

Access to a full range of industry content, analysis and expert commentary.